Odds of mkts hitting new highs in 2010 low: Morgan Stanley

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Q: Would you rather be slightly more defensively placed than being very high beta?

A: Yes absolutely. I think at this stage of the cycle, that's the way to be so. Therefore, the biggest overweights we have in our portfolio is across the world today are basically consumer staples and consumer discretionary stocks. We are also very seriously examining some telecom stocks across the world because those have been beaten down and everyone hates them.

In India it sort of beginning to look a bit interesting, although that might be more stock specific rather than sector specific. However, these are the sectors which are intriguing us much more. The one sector that we really don't like any more, which we use to like when we spoke last time around six-nine months ago, was financials. I do not know as to what is the good case scenario for them unless we get this magical scenario where growth continues and for some reason commodity price inflation comes off.

Otherwise if growth continues and it leads to high interest rates that's not good for financials. On the other hand if we have a growth relapse because of some fear of double dip or some accident in some place of the world that's not good financials either. So that's one sector where we have changed in a major way since we last spoke in April-May last year.

Q: Does that make you bearish on India because if commodities do not perform and financials don't those are the two big legs of our market?

A: One thing about the market we have seen basically is that leadership always changes. In 2000 when we were bearish on technology, people would keep asking us that if we are going to be really bearish on technology how is this market going to work and we know that something new came up. So, I think that for the emerging markets the most important sector which has to work is the consumer sector because if that does not work then the emerging market growth story is not going to take off. A lot of the investment themes have been played out.

So one theme that we are bearish on currently is China investment theme. We find that the investment rates in China are very high, it's an over invested country and the capex levels are very high.

What will happen if China's capex theme comes off? Will the consumer sort of pick up some of the slack? So, I think that across the world that's the way we are seeing it that don't get too bearish because the leading sectors today aren't looking that good because something new will always come up. The consumer sector despite all its promise is still a very small share of the marketcap. The commodity sector is very big. In fact, it is almost too big that in the emerging market space commodities are 30% of the index. If you look at the developed markets - that level is something like 15% or something. So, I think that these trends and leadership changes overtime. It's always good to look for the new leadership rather than be waded by the current trends.

Q: Do you think India has a chance of hitting a new year high somewhere in 2010 or is that being too optimistic because it's only 25% though it's measured from 17,000?

A: I will go back to the old point--it depends on what drives the next 10% return. If it is driven by further higher commodity prices, then we are not going to get to new highs. If the next 10% is driven by the out performance of the consumer sectors, that's a very good sign. It means that we can get to that level.

I still think that the odds are low that we get this magical scenario where in 2010 we hit new highs based on the fact that the reaction function of markets continues to be a bit troubling just now. If you are to get disinflationary move where inflation or commodity prices come off, then the chances of us hitting a new high improves significantly.

Q: You have given us various scenarios, but at the pit of your stomach are you more bearish than bullish now?

A: At the margin yes, but we are basically investing in what we call this horizontal world, which is that the sort of environment that we have seen historically, where we get v shape recoveries and then goes sideways for a long period of time. That's our base case scenario. We are also looking for these catalysts basically, as to what could turn scenarios around that we would turn maximum bearish if we have to get more than USD 90.

If you have to get into that zone on oil, we would turn really bearish and we would be willing to get into a much more bullish view if we have to get in disinflationary cycle because that's what really good bull markets are build on. Currently, as I said we are investing in horizontal world, which is not taking too many global macro bets but taking very specific country bets and taking some big sector bets as well. That's the way to go for the near future.